The 60th anniversary of the Bretton Woods insti-tutions has stimulated debate on the IMF’s future

as well as its evolution to date. In a June 10 sympo-sium on the IMF and the World Bank in the 21st cen-

tury, sponsored by the Bretton Woods Committee,Timothy Geithner (president of the U.S. FederalReserve Bank of New York and former Director of theIMF’s Policy Development and Review Department)and William Rhodes (Chair of Citibank) offeredadvice on how the IMF could adapt to a changingglobal economy and ensure that it remains a relevantand effective institution for its membership.

As the IMF looks ahead in this new century, one ofits most pressing challenges, Timothy Geithner said,will be helping emerging market economies reducetheir vulnerability to financial crises. Over the pastdecade, emerging market economies have madeprogress toward this goal, reflecting the increasedsophistication and skill of their economic policy-makers. Many of them have, on average, increasedinternational reserves (providing a larger financialcushion); improved fiscal

InternationalMonetary FundVOLUME 33NUMBER 12JUNE 28, 2004

In this issue

181De Rato begins Asia visit

181Bretton Woodsinstitutions in 21st century

186De Rato on IMF at 60

187Ahluwaliacongratulated on new post

188Fiscal adjustment in IMF-supportedprograms

192Gulf states tacklelabor market strains

194Caribbean faces upto globalization

196G8 agree on moresupport for HIPCInitiative

and…

184Recent publications

186Selected IMF rates

190IMF arrangements

191New on the web

181(Please turn to page 183)

Asia trip

De Rato underscores Japan’s and China’skey economic roles

Bretton Woods institutions in 21st century

How can the IMF uphold its role as guardian of the global financial system?

IMF Managing Director Rodrigo de Rato wrappedup the first half of his trip to Asia after meeting

with Japanese and Chinese leaders to seek their viewson national and international matters. In Tokyo onJune 22, he expressed optimism that Japan is “witness-ing the end of a long economic crisis” and appears ontrack to record growth in the realm of 41/2 percent for2004. In Beijing on June 24, he lauded China’s tremen-dous progress “in securing a higher standard of livingfor its people and in reducing poverty” and indicatedthat the IMF stands ready to assist China in its reformsin any way possible—“including in further strengthen-ing the financial sector.” De Rato will conclude his visitto Asia with consultations with leaders in Singaporeand Vietnam.

After discussions with Japanese Prime MinisterJunichiro Koizumi, Finance Minister SadakazuTanigaki, and Bank

In Tokyo, IMF Managing Director Rodrigo de Rato meetswith Japanese Finance Minister Sadakazu Tanigaki.

Geithner (left): The IMF “probably needs to raise thebar to increase the level of ambition of its policyrecommendations.”

(Please turn to the following page)

www.imf.org/imfsurvey

June 28, 2004

182

of Japan Deputy GovernorToshiro Muto, de Rato stressed that “the recovery haspicked up pace and is broadening, and deflationarypressures are lessening.”

The improved situation partly reflects a strongerglobal economy, but it also “owes much to steady pol-icy efforts at home,” de Rato said. Speaking withreporters at the Japan National Press Club in Tokyo, hecommended the reforms implemented under PrimeMinister Koizumi’s government, saying that they havebenefited not only Japan’s economy but also Asia andthe world. The IMF is convinced, that with “the con-tinuation of the reform agenda of the Prime Minister,and with the current stance of the Bank of Japan,things could be even brighter in the near future.”

No time for complacencyDe Rato also explained, though, that while the cur-rent situation gives considerable reason for opti-mism, “important challenges remain, and reforms,including to stabilize the public debt and furtherstrengthen the financial system, will be needed toensure a strong and durable expansion.” Reiteratingthe message that the IMF staff team conveyed to theauthorities during the Article IV consultation inMay, he encouraged Japan to take advantage of thecurrent favorable global economic climate to pursuefurther reforms, not just by tackling remaining cor-porate and financial sector weaknesses and endingdeflation but also by undertaking medium-term fiscal consolidation and wide-ranging structuralreforms to boost Japan’s long-term growth prospects.

Economic upswings, such as the current one, deRato told reporters, offer “a very good moment” forall economies to pursue reforms that will, over thelonger term, pay off in terms of sustained growth.Asked specifically about the sustainability of U.S.trade and current account deficits, he said that theIMF, the U.S. monetary authorities, and the U.S.Treasury are in accord on the need for an increase indomestic savings, essentially through a reduction ofthe public deficit. Indeed, countries with aging pop-ulations and those seeking to attract foreign capitalshould be giving a lot of attention to the issue ofpublic debt, he noted.

As for the potential for a disorderly correction inthe value of the U.S. dollar, de Rato said that whilevolatile movements cannot be ruled out, there is nowa “much more calm” situation. But here, too, themoment to begin to redress imbalances is now. If notdone, he suggested, those imbalances “will comeback to us in a higher degree of volatility.”

IMF view on regional integrationTurning to the push for greater regional integrationin Asia, including a possible regional monetary fund,de Rato assured the press that not only is the IMF fol-lowing such developments in Asia and elsewhere withinterest, but it is also taking “an active role as much aswe can.” The IMF remains convinced, he said, thatthere is, more than ever, a need for an internationalinstitution to guarantee global financial stability, butit sees no contradiction between the IMF’s interna-tional role and regional initiatives such as the ChiangMai arrangement on currency swaps.

Regarding the prospects for Asian currency inte-gration, de Rato noted that the European Union’sexperience testifies to the fact that monetary unionsare possible and are successful. But they do entail cer-tain prerequisites in terms of economic and marketintegration, and they do require political commit-ment. Currencies are not only economic instruments,he noted, they are also political instruments.

China seeks soft landingFrom Japan, de Rato traveled to Beijing, where hemet with Premier Wen Jiabao, People’s Bank of ChinaGovernor Zhou Xiaochuan, Finance Minister JinRenqing, and Liu Mingkang, Chair of the BankRegulatory Commission. The discussions were wideranging, with considerable emphasis on the currentstate of the Chinese economy and the authorities’recent efforts to slow growth to a sustainable level byaddressing overinvestment.

De Rato also discussed the exchange rate questionand was pleased to hear the authorities reiterate theirview that greater exchange rate flexibility is a desiredgoal for China. The IMF has believed for some timethat this policy would be in China’s best interest, as itwould provide more room for the country to pursuean independent monetary policy and facilitate adjust-ment to structural changes. There was also anexchange of views on the Chinese government’sefforts to maintain the stability of the country’sfinancial system through banking reforms. De Ratorestated the IMF’s longstanding commitment to assistthat reform effort in any possible way, including withtechnical assistance.

De Rato praises Japanese reform efforts(Continued from front page)

Rodrigo de Rato’s statements at the conclusion of his visits toJapan and China, as well as the transcript of his remarks atthe Japan National Press Club, are available on the IMF’swebsite (www.imf.org).

Importantchallengesremain, andreforms,including tostabilize thepublic debt and furtherstrengthen thefinancial system,will be neededto ensure astrong anddurableexpansion.

—Rodrigo de Rato

June 28, 2004

183

performance; reducedexternal balances; shifted from fixed but adjustablepegs to more flexible exchange rate regimes; and low-ered inflation.

Still, the emerging market countries are not out ofthe woods yet, according to Geithner. “These aggre-gate improvements,” he said, “mask substantial differ-ences across countries and . . . areas of lingering vul-nerability.” For example, a number of countries facevery high and, often, still growing public sector debts.The challenge of managing such large debt burdens isexacerbated by the structure of this debt. With a sub-stantial share of the debt denominated in foreign cur-rencies and carrying short maturities, these countriesare vulnerable to foreign currency, liquidity, andinterest rate risk. In some countries, Geithner added,large public sector debts have left banking systemshighly exposed to the state, constraining govern-ments’ room for maneuver. Recent improvements inexternal positions could also be reversed as domesticdemand strengthens. In addition to the risk of crises,he said, large debts could depress domestic invest-ment and long-term growth.

The IMF can help these countries become morestable financially, Geithner said, “by promoting anunwinding of these large balance sheet risks and, atthe same time, providing a credible form of contin-gent insurance for those hopefully rare circumstanceswhen its members face extraordinary financingneeds.” But the IMF would be better able to help, hesaid, if it took steps to strengthen its own policyadvice, surveillance, framework for sovereign debtrestructuring, and financing instruments.

Policy adviceGeithner noted that studies by IMF staff and theIndependent Evaluation Office, among others, havecriticized the IMF’s reform prescriptions as insuffi-ciently ambitious and as deferring too much to mem-bers’ domestic political constraints on adjustmentand reform. One result, he said, is that members haverun exchange rate regimes incompatible with the restof the policy framework. Another criticism is that theIMF has not been effective in addressing increases indebt that have created balance sheet problems andmade emerging market country crises so damagingand difficult to resolve. The studies also found theIMF overly accommodative of members’ unrealisticpolicy decisions.

Although Geithner characterized the criticisms asunfair in the degree of influence they expect the IMFto exert over a member country, he acknowledged

that they have substantial merit. Thus, he said, theIMF “probably needs to raise the bar to increase thelevel of ambition of its policy recommenda-tions.” It should not acquiesce to and validatepolicies that fall substantially short of what isrequired in the prevailing environment. As aremedy, Geithner proposed a risk-based frame-work for determining the hierarchy of policypriorities. Under such a framework, there wouldbe a sharper focus on unwinding balance sheetproblems, reducing sovereign debt to more sus-tainable levels, increasing buffers against liquid-ity problems, and preserving appropriateexchange rate arrangements. Addressing theseissues, he said, would help reduce the risk offuture capital account crises and improve theconditions for private sector growth.

Surveillance framework Another area that could stand strengthening is theIMF’s existing surveillance framework, throughwhich it delivers policy advice to its members. In itscurrent form, Geithner observed, it is not wellsuited to small open emerging market economieswith fragile credibility, limited buffers againstshocks, and considerable exposure to a rapidlychanging economic and financial environment.He also argued for more frequent and candid assess-ments of member economies. Now, they occur onlyevery 12–24 months and are published only with themembers’ agreement. This arrangement “tends totake the edge off the diagnoses and the prescrip-tions.” Furthermore, the assessments represent thejudgments of the IMF’s Executive Board and not thestaff, so that risks are not clearly and candidly iden-tified and explored. Finally, he noted, there are noconsequences for members because critical evalua-tions can be withheld from the public.

The IMF has considered a number of ways ofstrengthening surveillance, Geithner noted. One ofthe most promising entails more frequent publica-tion of staff assessments of members’ performanceagainst a medium-term framework that each mem-ber country would design. These assessments wouldthen measure the progress countries are making inreducing vulnerabilities, improving resilience, andstrengthening the structural underpinnings ofgrowth. Geithner also argued that such a frame-work should be combined with contingent access toIMF resources. Currently, surveillance does not pro-vide a meaningful check on members’ policiesbefore they are adopted, even though good policies

Geithner on bolstering IMF effectiveness(Continued from front page)

Geithner: Providingaccess to supplementalresources on aprecautionary orcontingent basis couldhelp prevent short-termliquidity crises frombecoming full-blownsolvency problems thatlead to default.

June 28, 2004

184

are a country’s best defense against crises.Moreover, the IMF makes resources availableonly when the financing need is acute.

Providing access to supplemental resourceson a precautionary or contingent basis couldhelp prevent short-term liquidity crises frombecoming full-blown solvency problems thatlead to default. “With an enhanced surveillanceframework designed to help keep policy on astronger path that does reduce risk over time,and with contingent finance that could bemobilized quickly,” Geithner argued, “the IMFwould be better positioned to contain the riskof deeper financial crisis.”

Framework for sovereign restructuringIn the past few years, some progress has been madein improving the framework for restructuring sov-ereign debt. Geithner noted, in particular, that col-lective action clauses have become the market stan-dard for emerging market governments issuing debtunder foreign law.

Geithner laid out his view of how the interna-tional community could credibly approach situa-tions in which a country must restructure its oblig-ations to private creditors. He proposed two condi-tions for the IMF to lend to a country in default.

First, the country should commit to a crediblemedium-term adjustment program that offers theprospect of a successful restructuring and a reason-ably early return to the capital markets. The coun-

try must determine its own adjustment path, whichmust be endorsed by the IMF.

And, second, the country should develop, in con-sultation with its advisors, a credible and moni-torable framework for a viable debt restructuringthat leaves it with a sustainable debt burden. Thisframework should be outlined to the IMF andaccepted by the country’s creditors. It would alsoneed to be consistent with the country’s macroeco-nomic framework and repayment prospects.

Reaffirming these conditions as the foundationfor IMF support in restructuring countries’ arrears,Geithner said, would improve the system and betterprepare the IMF to contribute to the favorable reso-lution of future crises that involve restructurings.

Financing instruments Finally, Geithner suggested some changes that wouldmake the IMF’s financing instruments more effectivein dealing with the challenges inherent in an increas-ingly integrated global economy. The reforms of the1990s (including the increase in the financial size ofthe IMF, new facilities, and greater flexibility in thephasing of resources) were important, he said, as havebeen more recent IMF reforms designed to preventthe institution from making large-scale disburse-ments available without assurances that they wouldcontribute to the resolution of a crisis.

Geithner proposed building on this recent progressby adding elements of a credible insurance mecha-nism to the IMF’s facilities. What would be needed?

Rhodes exhorted theIMF to keep twothings constant:its support ofmeaningful reformsand its role as acatalyst for privatesector finance.

IMF Working Papers ($15.00)04/84: “Does Financial Globalization Induce Better

Macroeconomic Policies?” Irina Tytell, Shang-Jin Wei

04/85: “Interest Rate Defenses of Currency Pegs,” Juan Sole

04/86: “Japan’s Distressed Debt Market,” Kazunari Ohashi

and Manmohan Singh

04/87: “Revisions Policy for Official Statistics: A Matter of

Governance,” Carol S. Carson, Sarmad Khawaja, and

Thomas K. Morrison

04/88: “Productivity Shocks, Learning, and Open Economy

Dynamics,” Roland E. Daumont

04/89: “Does Regulatory Governance Matter for Financial

System Stability? An Empirical Analysis,” Udaibir S. Das;

Marc G. Quintyn, and Kina Chenard

04/90: “Forecasting Thailand's Core Inflation,”Tao Sun

04/91: “Capital Income Taxation and Economic Growth in

Open Economies,” Geremia Palomba

04/92: “A Cointegration Model for Search Equilibrium

Wage Formation,” Lourens Broersma, Frank A.G. den

Butter, and Udo Kock

04/93: “Debt Accumulation in the CIS-7 Countries:

Bad Luck, Bad Policies, or Bad Advice,”

Thomas F. Helbling, Ashoka Mody, and Ratna Sahay

IMF Country Reports ($15.00)(Country name represents an Article IV consultation)

04/92: British Virgin Islands—Overseas Territory of the

United Kingdom: Assessment of the Supervision and

Regulation of the Financial Sector, Volume I—Review of

Financial Sector Regulation and Supervision

04/93: British Virgin Islands—Overseas Territory of the

United Kingdom: Assessment of the Supervision and

Regulation of the Financial Sector, Volume II—Detailed

Assessment of Observance of Standards and Codes

04/94: Norway

04/95: Burkina Faso: First Review Under the Three-Year

Arrangement Under the PRGF, and Request for Waiver

of Performance Criterion

04/96: India: Report on Observance of Standards and

Codes—Data Module

Recent publications

04/97: Democratic Republic of the Congo: Third Review

Under the Three-Year Arrangement Under the PRGF

and Request for Waiver of Performance Criteria

04/98: Ukraine: Report on the Observance of Standards

and Codes—Fiscal Transparency Module

04/99: Guinea

04/100: Guinea: Statistical Appendix

04/101: Belize: Selected Issues and Statistical Appendix

04/102: Belize

04/103: Singapore: Selected Issues

04/104: Singapore: Financial System Stability Assessment,

including Reports on the Observance of Standards and

Codes

04/105: Singapore

04/106: Philippines: Report on the Observance of

Standards and Codes—Banking Supervision

04/107: Democratic Republic of São Tomé and Príncipe:

Statistical Appendix

04/108: Democratic Republic of São Tomé and Príncipe

04/109: Peru: Report on the Observance of Standards and

Codes—Fiscal Transparency Module

04/110: Islamic State of Afghanistan: Staff-Monitored

Program

04/111: Chad

04/112: Israel: Report on Observance of Standards and

Codes—Fiscal Transparency Module

04/113: Romania: Ex Post Assessment of Longer-Term

Program Engagement

June 28, 2004

185

First, before receiving IMF resources, a country’s pol-icy framework should be strong enough to restoreconfidence. Second, to help catalyze other resources,the IMF must calibrate the scale of the resources itprovides to the country’s need. Third, the IMF mustbuild in the flexibility to structure programs appro-priate to a country’s circumstances and policy efforts.(For example, the IMF should be able to front-loadfinancial packages when that would be warranted.)Fourth, the IMF should be prepared to support coun-tries in pursuing reasonable restructuring proposalswhen circumstances warrant. And, fifth, the IMFshould take steps to avoid either the reality or theperception that it can be induced to accept weak pro-grams to allow a country to refinance its exposure.

These are modest proposals, Geithner said, andwould not fundamentally alter the balance establishedby the IMF’s Articles of Agreement between the rightsand the obligations of its member countries. Thesechanges would, however, help the IMF deal withfuture financial pressure in emerging market coun-tries. “And, given the scale of the economic costsimposed by recent crises, that is an important goal.”

View from the private sectorSpeaking from the perspective of a large internationalbanking concern, William Rhodes noted the IMF’sevolution over the past 60 years and exhorted it tokeep two things constant: its support of meaningfulreforms that meet the organization’s high standardsand its role as a catalyst for private sector finance,

which ensures that countries have access to theresources they need to grow. Experience has proved,he said, that the right mix of policy and officialfinancing can restore investor confidence and catalyzeprivate finance even in the most severe crises.

What should the IMF keep in mind as it looks tothe future? Rhodes outlined five points that he wouldlike to see the IMF take into account as it positionsitself to uphold its key role as guardian of the interna-tional monetary system:

• Focus more on crisis prevention, including tak-ing steps to strengthen Article IV consultations.

• Increase transparency. The IMF has made greatprogress but can do more.

• Work more closely with the private sector tohave an informed market perspective. Rhodespointed to the Capital Markets Consultative Group asa step in the right direction, adding that this initiativeshould be continued and even strengthened.

• Enhance credibility, which requires that the IMFcarefully balance its roles of creditor and arbiter.

• Uphold its stated principles on a consistent basis.

Elisa DiehlIMF External Relations Department

For more information on the Bretton Woods Committeeevent on June 10—which also honored Paul Volcker, formerU.S. Federal Reserve Board Chair, with its first GlobalLeadership Award—see www.brettonwoods.org.

Publications are available from IMF Publication Services, Box X2003, IMF, Washington, DC 20431 U.S.A.Telephone: (202) 623-7430; fax: (202) 623-7201; e-mail: publications@imf.org.

For information on the IMF on the Internet—including the full texts of the English edition of the IMF Survey, the IMF Survey’sannual Supplement on the IMF, Finance & Development, an updated IMF Publications Catalog, and daily SDR exchange rates of 45currencies—please visit the IMF’s website (www.imf.org). The full texts of all Working Papers and Policy Discussion Papers are alsoavailable on the IMF’s website.

June 28, 2004

186

IMF Managing Director Rodrigo de Rato said in a June 14 speech in Madrid that the IMF should

look for new ways to encourage countries to heed itsadvice and that there is substantial room for improv-ing the IMF’s surveillance of member countries’ econ-omies. “In the area of surveillance, success cannot relyon early warning alone, it must also prompt earlyaction,” he said at an event organized by Spain’s cen-tral bank and the IMF to mark the 60th anniversaryof the Bretton Woods institutions.

IMF surveillance consists of confidential policyadvice, coupled with peer pressure from other coun-tries. “But peer pressure can also mean peer protec-tion,” de Rato said. In a world increasingly defined by

financial globalization, it is no longer enough simplyto focus on individual countries and their exposure tocrisis. “Even if a country is not itself at risk, it may becontributing to global imbalances and placing the restof the world at risk.” In this respect, he called on theUnited States to reduce its deficit and on Japan andEurope to promote economic growth by reformingtheir economies.

Large loans may still be necessaryDe Rato also responded to those who have criticizedlarge loans to emerging market countries such asKorea, Brazil, and Turkey. “Some large IMF-supportedprograms raise concerns because they appear to sug-gest that a country’s geopolitical importance or otherfactors play a role in IMF loan decisions,” he said. Butwhile such loans draw a lot of attention, “the IMF hasalso given major support to countries whose situationdoes not pose systemic risks or which may not rankhigh on the geopolitical agenda of our largest share-holders.”

The IMF’s lending decisions must reflect the principleof uniformity of treatment. And since no country isexactly like another, the IMF has developed financialarrangements that meet different needs. In most cases,the normal access limits that apply to IMF loans are suf-ficient, but in some rare cases,“exceptionally large accessto IMF resources can be necessary to guard against risksto the global financial system,” de Rato said.

Large loans are made necessary by financial global-ization, a process that should mostly be welcomedbecause it provides opportunities for private capital tofinance investment in countries that can use the money

Even if acountry is notitself at risk,it may becontributingto globalimbalancesand placingthe rest of theworld at risk.—Rodrigo de Rato

Bank of Spain–IMF conference

Preparing the IMF for new challenges ahead

Selected IMF rates

Week SDR interest Rate of Rate ofbeginning rate remuneration charge

June 14 1.83 1.83 2.82June 21 1.84 1.84 2.83

The SDR interest rate and the rate of remuneration are equal to aweighted average of interest rates on specified short-term domesticobligations in the money markets of the five countries whose cur-rencies constitute the SDR valuation basket. The rate of remunera-tion is the rate of return on members’ remunerated reserve tranchepositions. The rate of charge, a proportion of the SDR interest rate,is the cost of using the IMF’s financial resources. All three rates arecomputed each Friday for the following week. The basic rates ofremuneration and charge are further adjusted to reflect burden-sharing arrangements. For the latest rates, call (202) 623-7171 orcheck the IMF website (www.imf.org/cgi-shl/bur.pl?2004).

General information on IMF finances, including rates, may be accessedat www.imf.org/external/fin.htm.

Data: IMF Finance Department

The Bank of Spain in Madrid served as the conference venue.

June 28, 2004

187

productively. But according to de Rato, promised gainsfrom financial globalization have yet to be fully realized.In fact, in many emerging market countries, capitalflows have themselves been a source of volatility. Thishas created a new breed of shocks that are much harderto manage than the current account imbalances theIMF has traditionally dealt with.

Korea is one example of a country that required asubstantial loan from the IMF to help it restore finan-cial stability. The IMF’s $21 billion loan package toKorea in December 1997 was a very large loan by anystandards, but it paid off: the country experiencedstrong economic growth by 1999 and even managedto repay the IMF ahead of schedule.

But while exceptional situations may requireexceptional steps, “we also clearly need an IMF thatcan say ‘no’ selectively, perhaps more assertively, and,above all, more predictably,” de Rato said. If countriesknew that the IMF might decline to lend in some cir-cumstances, they might adopt better policies in thefirst place. “To do this, we may have to think of waysof linking access to IMF resources more explicitly to acountry’s policy efforts before the crisis,” de Rato said.

Coordination is keyThe IMF should also review its work in low-incomecountries. De Rato hoped that an upcoming report

by the IMF’s Independent Evaluation Office on thePoverty Reduction and Growth Facility (the IMF’sprimary facility for lending to poor countries) and onPoverty Reduction Strategy Papers (which all poorcountries receiving assistance from the IMF arerequired to submit) would help shed light on how theIMF can become more effective in its dealings withlow-income countries.

The IMF should ensure better coordination withother international institutions such as the WorldBank, various United Nations agencies, regionaldevelopment banks, and the World Trade Organiza-tion, de Rato also said. This particular challenge ispresent in all the IMF’s work, “but is especiallyimportant for our work in low-income countries,where we are only one partner among many inhelping them achieve their longer-run developmentgoals.”

IMF Managing Director Rodrigo de Rato’s speech, “The IMFat 60—Evolving Challenges, Evolving Role,” was delivered on June 14 at a conference entitled “Dollars, Debts, andDeficits—60 Years After Bretton Woods,” organized jointly bythe Bank of Spain and the IMF. The full text of the speech isavailable on the IMF’s website (www.imf.org).

De Rato congratulates Ahluwalia on new post

On June 21, IMF Managing Director Rodrigo de Rato con-

gratulated Montek Singh Ahluwalia, the first director of

the IMF’s Independent Evaluation Office (IEO), on

Ahluwalia’s appointment as Deputy Chair of India’s

Planning Commission (a cabinet-level position). Ahluwalia,

an Indian national with extensive experience in Indian gov-

ernment, had headed the IEO from July 2001. The office was

created to conduct independent analyses of IMF policies and

activities and, in so doing, strengthen the institution’s learn-

ing process.

In setting out the IEO’s first work program, Ahluwalia

undertook extensive consultations, inside and outside the

organization, which led to the selection of three initial topics

for the IEO’s review: fiscal adjustment in IMF-supported

programs; the role of the IMF in three capital account crises

(Indonesia, Korea, and Brazil); and the prolonged use of

IMF resources. These studies, which were presented to the

IMF’s Executive Board in 2002-03, were subsequently

released to the public and have contributed to a number of

changes in IMF policies and procedures.

Under Ahluwalia’s guidance, the IEO embarked on a sec-

ond set of studies. Reports on these reviews are expected to

be brought to the Executive Board this year. Topics include

a review of the IMF’s Poverty Reduction and Growth

Facility (the IMF’s chief vehicle for providing concessional

financing to low-income countries) and the joint

IMF–World Bank Poverty Reduction Strategy Papers

(which encourage country design and ownership of

reforms and set a road map for development); the role of

the IMF in Argentina from 1991 through 2002; and the

IMF’s technical assistance program.

In congratulating him, IMF

Managing Director Rodrigo de Rato

noted that Ahluwalia had served with

distinction as the IEO’s first director

and that the IMF has benefited greatly

from the IEO’s well-researched and

insightful reports on the organization’s

programs and policies. De Rato added

that Ahluwalia’s distinguished career

in public service has been dedicated to

the pursuit of sound economic poli-

cies. “As India continues on its path

of economic reforms,” he said, “it

comes as no surprise to me that the

authorities have once again turned to

Mr. Ahluwalia for his services. He is

dedicated and committed and will be

missed at the IMF and the IEO.”

June 28, 2004

188

One aspect of IMF operations that has tradition-ally drawn a great deal of attention is its fiscal

policy advice to member countries. Is it, as somecritics argue, too stringent, too inflexible? At a June 8

IMF Book Forum, Marcelo Selowsky (AssistantDirector of the IMF’s Independent EvaluationOffice (IEO)), Allan Meltzer (Carnegie-MellonUniversity and American Enterprise Institute),and Nancy Birdsall (Center for Global Develop-ment) debated these questions.

Does the IMF use a “cookie cutter” approachwhen it dispenses fiscal policy advice? Criticsoften characterize the IMF’s fiscal policy adviceas “one size fits all” and argue that its steady pre-scription of fiscal austerity curtails economicgrowth and social expenditures, and harms thepoor in particular. Others suggest that its focus

on reducing fiscal deficits introduces inefficienciesand inequalities and may not help countries achievedurable structural changes.

Unwarranted criticism?But how valid are these criticisms? A September 2003report, Fiscal Adjustment in IMF-Supported Programs,by the IEO provides some answers. Selowsky, lead

author of the report, explained that the IEOstudy found much more variation in the patternof fiscal adjustment across programs than is gen-erally assumed. Contrary to the general percep-tion that IMF-supported programs invariablyenforce austerity, for example, the study identi-fied many instances in which fiscal deficits wereactually projected to widen and expenditures toincrease as a percentage of GDP. It also found nogeneralized evidence (other than in capitalaccount crises) of a slowdown in growth duringprogram years compared with precrises averages.

In certain areas, however, Selowsky noted apossible bias in program design. “We found thatthe IMF is extremely optimistic in projecting the

recovery of private demand and growth, particularlywhen the country is going through a very roughperiod,” he said. This optimism can lead to an under-statement of the need for a more countercyclical fiscalstance and to a fiscal stance that is too tight. As privatedemand recovers less than projected, the end resultmay be a shortfall in total aggregate demand. Obvi-ously, the fiscal stance should not depend solely oncountercyclical considerations when the level of debt

is already too high, Selowsky explained. The problemis that all these considerations behind the fiscal stanceare not well explained in program documents. Thereis no clear rationale for the magnitude and pace of theenvisaged fiscal adjustment. In Selowsky’s view, pro-grams rely too much on value-added taxes and notenough on efforts to reduce evasion of customs,income, and corporate taxes. “The IMF is not forcefulenough in encouraging the authorities to collect fromwell-known taxpayers in arrears, particularly if theyare powerful.”

Looking at the impact of fiscal adjustment on socialsector expenditures—which are critical for the welfareof the poor—the study concluded that, on the whole,social spending was not lower than it would have beenin the absence of an IMF program. In-depth countrystudies show, however, that even when aggregate socialexpenditures are maintained, those most relevant tothe poor may be crowded out by, for example, govern-ment salaries.

The IEO report makes specific recommendationsin these areas. Surveillance should set a clearroadmap of structural fiscal reforms and unbundleconstraints to action. Surveillance and programsshould mutually reinforce each other over time, withsubsequent programs picking up reforms that requiremore time so as to ensure cumulative progress.Regarding social issues, the report urges the IMF toplay a major role in encouraging countries to prepareprograms and systems to protect the most vulnerablesegments of society in case of budgetary retrench-ments. Such measures cannot be put together at thelast minute in the midst of a crisis. Governmentsshould take the lead, which would also strengthentheir program ownership, Selowsky said.

Importance of politicsBoth Meltzer and Birdsall praised the IEO’s study astechnically sound. It is, Meltzer observed,“comprehen-sive, careful, and balanced in its judgment.” Birdsallapplauded it for “responding to long-standing, some-times misguided, exaggerated criticism of the way theIMF deals with fiscal reform issues.” At the same time,however, she said “the report is willfully naive about thedifficult politics of distribution and welfare, particularlyin developing countries” where institutions are weak,checks and balances are missing, and sound economicinstitutions are not yet well developed.

What the IEO report does tell us, Meltzer pointedout, is that many countries miss their planned fiscal,

IMF Book Forum

Are IMF-prescribed fiscal targets too tight?

Selowsky: “The IMF isnot forceful enough inencouraging theauthorities to collectfrom well-knowntaxpayers in arrears,particularly if theyare powerful.”

Meltzer: Externaldevelopments clearlyplay a role, butpolitical supportrepresents the criticaldifference in whetherreform targets are met.

June 28, 2004

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economic growth, and structural reform targets. Why?Although external developments clearly play a role,he observed, political support represents the criticaldifference in whether these targets are achieved,adding that the report offers some explanation alongthese lines. It tells us, he said, that “insufficientprogress in structural reform in the fiscal area is animportant factor behind shortfalls in fiscal adjust-ment” and that “revenue from shortfalls seems to beassociated with weak implementation.”

Boosting program successWhat changes are needed to make more programssucceed? In the report, the IMF’s Executive Directorspoint to the need for strong country ownership of thefiscal reform agenda and implementation process.Meltzer found this suggestion appropriate and desir-able but added that “to be more successful in reform-ing fiscal and other policies in client countries, theIMF must reform itself.” The principal change mustbe “a shift away from current command-and-controlprocedures tied to dollops of money conditioned onthe promise to make reforms.”

In Meltzer’s view, the IMF’s Executive Board lacks“curiosity about why programs do not succeed.”If Executive Directors were serious about wantingprograms to succeed, he said, they would “shift to anincentive system where [IMF] payments are made forperformance, not promises.” It is instructive, he noted,that Turkey took implementation far more seriouslywhen it had the incentive of joining the EuropeanUnion, and “India got its incentive from comparingthe Hindu rate of growth to China’s vastly more suc-cessful program. Reforms that were previously politi-cally impossible became distinctly possible.”

Taking his argument a step further, Meltzer askedwhy development occurs in some countries but notothers. The answer is that institutions matter—a viewthat the current literature supports. Unless countriesadopt supporting institutions, sustained developmentdoes not occur. Crisis resolution and crisis avoidancealso depend on institutional reforms that require localleadership, sustained commitment, and the ability tomaintain and support reform during the often costlyadjustment period. The IMF, Meltzer said, “cannotbring a country to do what the citizens or their repre-sentatives do not want to do.” Birdsall agreed butadded that if a country does not respond to incentives,“we can’t just throw up our hands” and walk away.

Redefining the social contract The IEO report expresses concern about countries’ability to maintain social safety nets during periods ofadjustment and distress but says little about the effect

of shifting the burden of adjustment up the incomeladder, Meltzer said, adding that welfare decisions ofthis kind should be made locally, not in Washington.What incentive would the IMF have for reformingitself? It would be a way of telling its many vociferouscritics, he observed, that the IMF provides incentivesfor reform and adjustment, and leaves these welfareand distributional decisions to the countries.

The report suggests that “the IMF could invite theauthorities regularly during Article IV consultations toindicate which critical social programs and social ser-vices they would like to see protected in the event ofadverse shocks.” The idea is basically for the country totake ownership and to work out the design and bud-getary aspects of social programs with agencies thathave expertise in this area, such as the World Bank andthe World Health Organization, noted Selowsky.

Birdsall supported this recommendation, sayingthat inviting authorities to suggest which programsthey would want to see protected is consistentwith the IMF’s long-standing role in encourag-ing sound, medium-term fiscal programming,including fiscal restraint today to allow forcountercyclical spending tomorrow. In herview, the IMF would, in implementing this rec-ommendation, not only help countries protectfiscal adjustment from untoward political pres-sures but also rescue itself from the widespreadperception—which is hampering its effective-ness—that its “mindless and callous support offiscal discipline pushes spending reductionsonto the poor.”

In the 21st century, Birdsall concluded, theIMF should be called upon to send the message moreeffectively that social policy involves more thanincreased spending on education and health care. Thefoundation of a good social contract in an open econ-omy, she said, has to be fiscal discipline that willencourage lower interest rates, create jobs, minimizedebt buildup, and allow for countercyclical spending toprotect the poor. This will create the kind of politicalspace on both the expenditure and tax fronts “that willensure, in the long run, that the IMF is playing its wor-thy role in reducing poverty and inequality in theworld.”

Christine Ebrahim-zadehIMF External Relations Department

The full IEO report, Fiscal Adjustment in IMF-SupportedPrograms, is available at http://www.imf.org/External/NP/ieo/2003/fis/pdf/main.pdf. See also IMF Survey, September 8,2003, page 262, for a discussion with Marcelo Selowsky aboutthe study’s findings and recommendations.

Birdsall: Thefoundation of agood social contracthas to be fiscaldiscipline that willencourage lowerinterest rates, createjobs, minimize debtbuildup, and allowfor countercyclicalspending to protectthe poor.

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Stand-By, EFF, and PRGF arrangements as of May 31

Date of Expiration Amount UndrawnMember arrangement date approved balance

(million SDRs)Stand-ByArgentina September 20, 2003 September 19, 2006 8,981.00 4,810.00Bolivia April 2, 2003 June 15, 2004 85.75 21.43Brazil September 6, 2002 March 31, 2005 27,375.12 10,175.48Colombia January 15, 2003 January 14, 2005 1,548.00 1,548.00Dominican Republic August 29, 2003 August 28, 2005 437.80 306.46

Gabon May 28, 2004 June 30, 2005 69.44 69.44Jordan July 3, 2002 July 2, 2004 85.28 74.62Macedonia FYR April 30, 2003 June 15, 2004 20.00 8.00Paraguay December 15, 2003 March 31, 2005 50.00 50.00Turkey February 4, 2002 February 3, 2005 12,821.20 1,360.80

Ukraine March 29, 2004 March 28, 2005 411.60 411.60Uruguay April 1, 2002 March 31, 2005 2,128.30 559.20Total 54,013.49 19,395.03

EFFSerbia and Montenegro May 14, 2002 May 13, 2005 650.00 350.00Sri Lanka April 18, 2003 April 17, 2006 144.40 123.73Total 794.40 473.73

PRGFAlbania June 21, 2002 June 20, 2005 28.00 12.00Armenia May 23, 2001 December 31, 2004 69.00 9.00Azerbaijan July 6, 2001 March 31, 2005 80.45 38.61Bangladesh June 20, 2003 June 19, 2006 347.00 248.00Burkina Faso June 11, 2003 June 10, 2006 24.08 17.20

Burundi January 23, 2004 January 22, 2007 69.30 42.90Cameroon December 21, 2000 December 20, 2004 111.42 31.83Cape Verde April 10, 2002 April 9, 2005 8.64 3.72Congo, Democratic Republic of June 12, 2002 June 11, 2005 580.00 79.93Côte d'Ivoire March 29, 2002 March 28, 2005 292.68 234.14

Dominica December 29, 2003 December 28, 2006 7.69 5.02Ethiopia March 22, 2001 July 31, 2004 100.28 10.43Gambia, The July 18, 2002 July 17, 2005 20.22 17.33Ghana May 9, 2003 May 8, 2006 184.50 131.80Guyana September 20, 2002 March 19, 2006 54.55 43.03

Honduras February 27, 2004 February 26, 2007 71.20 61.03Kenya November 21, 2003 November 20, 2006 175.00 150.00Kyrgyz Republic December 6, 2001 December 5, 2004 73.40 19.12Lao People’s Democratic Republic April 25, 2001 April 24, 2005 31.70 13.58Lesotho March 9, 2001 June 30, 2004 24.50 3.50

Madagascar March 1, 2001 March 1, 2005 91.65 22.70Malawi December 21, 2000 December 20, 2004 45.11 32.23Mauritania July 18, 2003 July 17, 2006 6.44 5.52Mongolia September 28, 2001 July 31, 2005 28.49 16.28Nepal November 19, 2003 November 18, 2006 49.91 42.78

Nicaragua December 13, 2002 December 12, 2005 97.50 55.71Niger December 22, 2000 June 30, 2004 59.20 8.44Pakistan December 6, 2001 December 5, 2004 1,033.70 344.56Rwanda August 12, 2002 August 11, 2005 4.00 2.86Senegal April 28, 2003 April 27, 2006 24.27 17.33

Sierra Leone September 26, 2001 March 25, 2005 130.84 28.00Sri Lanka April 18, 2003 April 17, 2006 269.00 230.61Tajikistan December 11, 2002 December 10, 2005 65.00 39.20Tanzania August 16, 2003 August 15, 2006 19.60 14.00Uganda September 13, 2002 September 12, 2005 13.50 8.00Total 4,291.82 2,040.39

EFF = Extended Fund Facility.PRGF = Poverty Reduction and Growth Facility.Figures may not add to totals owing to rounding.

Data: IMF Finance Department

Members drawing on

the IMF “purchase”

other members’

currencies, or SDRs,

with an equivalent

amount of their own

currency.

June 28, 2004

191

Available on the web (www.imf.org)

Press Releases04/105: IMF Executive Board Reviews Djibouti’s Poverty

Reduction Strategy, June 4

04/106: Statement by IMF Staff Mission to Malawi, June 4

04/107: IMF Approves $144 Million PRGF Arrangement for

Georgia, June 4

04/108: IMF Statement on the Conclusion of 2004 Article IV

Consultation Discussions with Jamaica, June 4

04/109: IMF Completes Third Review and Approves

$147 Million Under Extended Arrangement with Serbia

and Montenegro, June 7

04/110: IMF Managing Director Rato Names Jorge Márquez-

Ruarte as Human Resources Director, June 7

04/111: The Democratic Republic of Congo Formally Begins

Participation in the IMF’s General Data Dissemination

System, June 9

04/112: IMF Approves 26-Month $422.8 Million Stand-By

Arrangement for Peru, June 9

04/113: IMF Completes Third Review of Bolivia’s Stand-By

Arrangement, Approves $16 Million Disbursement and

Extension of Arrangement, June 10

04/114: IMF Completes Second and Third Reviews Under

Rwanda’s PRGF Arrangement, Approves $1.68 Million

Disbursement, and Grants Additional Interim Assistance

of $6.6 Million Under the Enhanced HIPC Initiative,

June 10

04/115: IMF Deputy Managing Director Takatoshi Kato’s

Statement at a Seminar in Trinidad and Tobago, June 14

04/116: IMF Managing Director Rodrigo de Rato to Visit

Japan, China, Singapore, and Vietnam, June 15

04/117: IMF Approves $320.41 Million PRGF Arrangement

for Zambia, June 16

04/118: IMF Executive Board Completes Seventh Review of

Brazil’s Stand-By Arrangement, June 18

04/119: Statement by IMF Managing Director on the

Appointment of Montek Singh Ahluwalia, June 21

(see page 187)

04/120: IMF Approves in Principle $16.6 Million PRGF

Arrangement for Mozambique, June 21

04/121: IMF Managing Director Rodrigo de Rato’s Statement

at the Conclusion of His Visit to Japan, June 22

(see page 181)

04/122: IMF Staff Statement on the Discussions of the

Eighth Review Under Turkey’s Stand-By Arrangement,

June 22

04/123: Statement by IMF 2004 Article IV Consultation

Mission to the Islamic Republic of Iran, June 23

04/124: IMF Executive Board Completes Eighth Review

Under Pakistan’s PRGF-Supported Program and Approves

Disbursement Amounting to $253 Million, June 23

04/125: IMF Approves $13.7 Million PRGF Arrangement

for Mali, June 23

04/126: IMF Managing Director Rodrigo de Rato’s Statement

at the Conclusion of His Visit to the People’s Republic of

China, June 24 (see page 181)

Public Information Notices04/63: IMF Executive Board Approves the FY 2005

Administrative and Capital Budgets, June 16

04/64: IMF Concludes 2004 Article IV Consultation with

Switzerland, June 18

04/65: IMF Concludes 2004 Article IV Consultation with

Bulgaria, June 18

Speeches“Economic Growth in a Shrinking World: The IMF and

Globalization,” Anne Krueger, IMF Acting Managing

Director, Pacific Council on International Policy,

San Diego, June 2

“Opportunities for Emerging and Developing Countries in

International Standard Setting: An IMF Perspective,”

Agustín Carstens, IMF Deputy Managing Director,

Fourth Annual IMF–World Bank–Federal Reserve

Seminar—“Basel II: The International Banking System at

the Crossroads,” Washington, D.C., June 2

“Promoting International Financial Stability: The IMF at

60,” Anne O. Krueger, IMF Acting Managing Director,

UCSD Economic Roundtable, San Diego, June 3

“Letting the Future In: India’s Continuing Reform Agenda,”

Anne O. Krueger, IMF Acting Managing Director,

Stanford India Conference, June 4

“Anti–Money Laundering and Combating the Financing of

Terrorism: The Challenges Ahead,” Agustín Carstens, IMF

Deputy Managing Director, IMF Seminar on Current

Developments in Monetary and Financial Law,

Washington, D.C., June 4

Opening Remarks by Takatoshi Kato, IMF Deputy

Managing Director, Seminar on Developmental

Challenges Facing the Caribbean, Port of Spain, Trinidad,

June 11

“The Caribbean Economies: Adjusting to the Global

Economy,” Anoop Singh, Director, IMF Western

Hemisphere Department, Seminar on Developmental

Challenges Facing the Caribbean, Port of Spain, Trinidad,

June 11

“The Role of the IMF in the Caribbean,” José Fajgenbaum,

Deputy Director, IMF Western Hemisphere Department,

Seminar on Developmental Challenges Facing the

Caribbean, Port of Spain, Trinidad, June 12

“The IMF at 60—Evolving Challenges, Evolving Role,”

Rodrigo de Rato y Figaredo, IMF Managing Director,

Bank of Spain and IMF Conference on Dollars, Debts

and Deficits—60 Years After Bretton Woods, Madrid,

June 14

TranscriptsPress Briefings by Thomas C. Dawson, Director, IMF

External Relations Department, May 13, May 27

“Standards and Codes: Can They Prevent Financial Crises?”

IMF Book Forum, May 27

Press Briefings by Rodrigo de Rato, IMF Managing Director,

June 9, June 22

PRGF=Poverty Reduction and Growth Facility

June 28, 2004

192

Over the past few decades, governments of themember countries of the Cooperation Council

for the Arab States of the Gulf (GCC) have acted asemployers of first and last resort. Nationals who soughtjobs found them in the public sector, while foreignworkers filled shortages in the private, non-oil sector.More recently, however, the number of young nationalsentering the workforce has increasingly outstripped theeconomies’ capacity to generate new jobs—a situationcompounded by structural problems in the labor mar-ket. In a new IMF Working Paper, Ugo Fasano of theIMF’s Middle East and Central Asia Department andRishi Goyal of the IMF’s Western Hemisphere Depart-ment examine how GCC governments can meet thischallenge. Christine Ebrahim-zadeh of the IMF Surveyspoke with them.

IMF SURVEY: How would you characterize the GCC’slabor markets at present?FASANO: Although labor market statistics are scant inGCC countries, there are signs that unemployment

pressures among nationals have started toemerge, particularly among first-time jobseekers. Search periods after graduation, forinstance, have become longer. However, theextent of those pressures differs across thecountries. Bahrain, Oman, and Saudi Arabia,which already have relatively high percentagesof nationals in their respective workforces, facemore pressing challenges than do Kuwait,Qatar, or the United Arab Emirates. In addi-tion, structural problems in the labor markets,such as mismatches in the skills supplied bynational workers and those demanded by theprivate sector, are hindering adjustment.

IMF SURVEY: What is driving the emerging strains inGCC labor markets?GOYAL: Three main developments. First, an increasingnumber of young nationals are entering the laborforce as a result of high fertility rates in recentdecades. It is estimated that the local labor force hasbeen growing, on average, by more than 4 percent ayear for the past several years in most GCC countries.With a substantial fraction of the population underthe age of 14 in all GCC countries and an increasingnumber of women entering the labor market, highlabor force growth rates are expected to continue overthe medium term.

Second, the governments’ role as employers of firstand last resort for their nationals has almost reached its

limits. In most of the countries, the wage bill nowexceeds 10 percent of GDP and cannot keep risingwithout jeopardizing priority spending in areas such aseducation and health care—areas that need to increase,given the demographic changes taking place—andwithout further weakening budgets’ capacity to with-stand oil price shocks. Governments have also startedto narrow their demand for nationals to professionalswho are specialized in these priority areas.

Third, growth of the non-oil sector has not acceler-ated in line with the rapid growth in the local laborforce. In addition, most new jobs are becoming avail-able in sectors such as trade, construction, manufac-turing, and domestic services, which require relativelylow skills and offer relatively low wages and have littleappeal for local workers. Meanwhile, the private sectorhas continued to have access to an elastic supply ofexpatriate workers at internationally competitivewages.

IMF SURVEY: You also mentioned that structuralweaknesses have exacerbated the problems.FASANO: The segmentation of the labor market—in terms of wages, skills, and sectors of employ-ment—will not make adjustment easy. Underlyingthis segmentation has been the implicit guarantee ofemployment for nationals in the government sectorand the relatively more flexible hiring and firing prac-tices that apply to expatriate workers. Nationals preferto work in the government sector because of its rela-tively high wages, social allowances, retirement bene-fits, job security, and shorter working hours. Thisimplicit guarantee for nationals has meant that thelowest acceptable wage for new entrants into the locallabor force is high.

In addition, as I mentioned earlier, the skillsnational workers have do not match the skillsdemanded by the private sector. The anticipation ofguaranteed public sector employment offers nationalslittle incentive to acquire the skills and training thatthe private sector values. And this is so even thougheducation is essentially free. It is also surprising thatenrollment in colleges and universities has remainedlow compared with countries with similar levels ofper capita income—although enrollment has risenover time.

IMF SURVEY: What have governments in the regiondone thus far to address this problem?GOYAL: Today, the percentage of GCC nationals work-ing for the public sector ranges from a low of 35 per-

Fasano: “Theanticipation ofguaranteed publicsector employmentoffers nationals littleincentive to acquirethe skills and training that the private sector values.”

Gulf states tackle labor market strains

June 28, 2004

193

cent in Bahrain to over 90 percent in the United ArabEmirates. Bahrain began to diversify its economy ear-lier than other GCC countries and now has a muchlarger number of nationals working in the private sec-tor. Endowed with smaller oil reserves, the Bahrainieconomy is the most diversified in the GCC area, withthe non-oil sector accounting for over 80 percent ofreal GDP and a financial sector that is the single mostimportant activity in the country.

Elsewhere in the GCC, the focus has shifted duringthe past decade to increasing job opportunities fornationals in the private sector. To this end, theauthorities have relied on a combination of manda-tory and administrative measures, complementedmore recently by market-based strategies. Mandatorymeasures have included quantitative targets or quotason the proportion of nationals employed by privatecompanies in specific professions or sectors.Administrative measures have increased the relativecost of hiring expatriates through regulation of thesupply of work permits for foreigners or fees andtaxes on employers who hire foreign workers. Theauthorities have also provided incentives to privateemployers to hire nationals by rewarding tenders thatmeet quota requirements.

These mandatory and administrative measures havebecome part of a broader effort to expand the skills ofnational workers by improving training and educationin line with private sector requirements. The authoritiesare intensifying efforts to eliminate the gap between theoutput of the local educational systems and the require-ments of the market, and are encouraging self-employ-ment opportunities by supporting the development ofsmall enterprises through financing and training.

IMF SURVEY: How successful have their efforts been?What lessons have been learned?GOYAL: The results have been mixed, with the sourcesof employment generation and its beneficiaries dif-fering across the countries. During the second half ofthe 1990s, the private sector created the majority ofjobs in Bahrain, Oman, and the United ArabEmirates. In contrast, the public sector accounted formore than three-fourths of employment creation inKuwait and about one-half in Saudi Arabia. Duringthe same period, nationals were the main beneficia-ries of job creation in Bahrain, Oman, and SaudiArabia, while expatriate workers reaped a large pro-portion of the new jobs created in Kuwait and theUnited Arab Emirates.

The absorption of national workers by the privatesector therefore remains a challenge. Mandatoryquantitative measures are difficult to enforce in prac-tice, particularly at the firm level. Besides, as most new

job opportunities require relatively low levels of edu-cation and pay relatively low wages, nationals appearunwilling to accept these positions, and, as a result, theprivate sector has continued to offer most of thesejobs to foreign workers.

Quotas should be applied with flexibility andpragmatism, taking into account labor marketconditions and regularly assessing the impact ofquotas on long-term job creation. Closing thelabor market to expatriate workers will in itselfnot diminish unemployment pressures in GCCcountries. Education and training systems areinsufficiently compatible with local labor mar-ket requirements, and this has hindered thereplacement of expatriates in skilled positions.In addition, wage expectations of the newentrants remain high and rigid, reflecting, inpart, continued expectations of public sectoremployment. There is preliminary evidence,however, that nationals may have started toaccept lower entry salaries in the past few years.

IMF SURVEY: What more can these countries do tomount an effective labor market strategy?FASANO: An effective labor market strategy shouldfocus on promoting a vibrant non-oil economy,strengthening investment in human capital, andadopting labor market institutional reforms. Robustnon-oil economic growth is not expected to be suffi-cient to create new jobs for nationals in the periodahead, as the authorities in the region have recog-nized. Thus, efforts are particularly needed to furtherintegrate the labor markets by addressing the causesbehind their segmentation.

An important component of such efforts is to nar-row the wage differential, including benefits, betweenthe public and the private sectors, by making, forinstance, social benefits available to all workingnationals irrespective of sector of employment and byannouncing and enforcing strict limits on public sec-tor employment.

The GCC countries will also need to strengtheneducational and vocational training to encourage skillacquisition by nationals and eliminate, over time, themismatch between skills supplied by national workersand those demanded by the private sector. Reformingschool curricula, encouraging firms to establishinternships, and awarding targeted training voucherscould help prospective national workers build theirskills and expertise.

Finally, the authorities should rely mainly on price-and market-based interventions—rather than quanti-tative ones—to encourage the substitution of nationalfor expatriate workers. The imposition of targets or

Goyal: “Educationand training systemsare insufficientlycompatible withlocal labor marketrequirements, andthis has hinderedthe replacement ofexpatriates in skilledpositions.”

June 28, 2004

194

The economic perfor-mance of the

Caribbean region has weak-ened in recent years, amid aseries of natural disastersand an increasingly com-petitive global economicenvironment. What can bedone to spur higher growthwas the topic of“Developmental ChallengesFacing the Caribbean”—a

seminar held in Trinidad on June 11–12. The event,part of celebrations marking the 40th anniversary ofthe Central Bank of Trinidad and Tobago, under-scored the urgency of encouraging more flexiblelabor markets and lowering debt ratios as these econ-

omies seek to become more adaptive to thedemands of a fast-changing global economy.

Since 1980, average per capita income inthe Caribbean region has grown by onlyabout 11/2 percent a year—roughly 1 percent-age point below the average for other devel-oping countries. In recent years growth hasslowed in several countries, notably those inthe Eastern Caribbean Currency Union. Atthe same time, fiscal balances have deterio-rated markedly, and public debt in 15 coun-tries of the Caribbean now averages morethan 90 percent of GDP. The region has also

suffered disproportionately from natural disasters,with several islands repeatedly devastated by hurri-canes. Most recently, severe floods devastated parts ofthe Dominican Republic and Haiti, particularlyaffecting the poor. In addition, two important ele-ments in the region’s economy—tourism and off-shore banking—were dealt a blow following theevents of September 11.

The region is a diverse one—populations rangefrom 81/2 million in the Dominican Republic to lessthan 50,000 in St. Kitts and Nevis, and GDP percapita varies from over $16,000 in The Bahamas toonly about $500 in Haiti. But there are a remarkablenumber of shared features, too. The region features,for example, a widespread commitment to democra-tic political systems, a relatively high level of educa-tional attainment, and natural beauty that makes itone of the world’s top tourist destinations. But, asone presenter put it, the economic performance canbest be described as middling. There is scope forimprovement, as “the Caribbean economies seem not to be performing at their full potential,” saidTakatoshi Kato (IMF Deputy Managing Director).

What is holding the region back? The main themeof the two-day seminar, which was jointly organizedby the Central Bank of Trinidad and Tobago and theIMF, is the difficulty Caribbean economies have hadin adjusting to the forces of globalization. As Ewart S.Williams (Governor, Central Bank of Trinidad andTobago) noted, globalization has expanded growthopportunities, but it has also created challenges formost developing countries “and certainly for those inthe Caribbean region.” One example of this has beenthe profound change associated with the dismantlingof trade barriers worldwide. This has eroded the pref-erential access that exporters traditionally have had toEuropean markets. Sugar and bananas—once main-stays of many Caribbean economies—are no longercompetitive.

Central Bank of Trinidad and Tobago–IMF seminar

The Caribbean faces up to globalization

Singh: "Fiscaladjustment andstructural reform can initiate a virtuouscircle toward debtsustainability andgrowth."

IMF DeputyManaging DirectorTakatoshi Kato (left)greets Trinidad andTobago Prime MinisterPatrick Manning.

Photo credits: Issei Kato for Reuters, page 181; Bretton

Woods Committee, pages 181 and 183-84; Eugene

Salazar and Michael Spilotro for the IMF, pages 183-85,

187-89, and 192-93; Bank of Spain, page 186; Central

Bank of Trinidad and Tobago, pages 194-96.

quotas may produce short-term positive results, butthis practice has, at best, ambiguous effects on long-term employment generation for nationals and couldhinder productivity growth and competitiveness.

Simulations that we conducted show that such astrategy could help alleviate unemployment pressureswhile striking a balance between maintaining a liberalforeign labor policy and a reasonable level of compet-itiveness of the non-oil sector. It is encouraging that

the labor market strategy across GCC countries pre-sents elements of this overall strategy.

Copies of IMF Working Paper No. 04/71, “Emerging Strainsin GCC Labor Markets,” by Ugo Fasano and Rishi Goyal, areavailable for $15.00 each. Please see page 184 for orderingdetails. The full text is also available on the IMF’s website(www.imf.org).

June 28, 2004

195

Benefiting from globalizationDespite difficulties, the region has, in many ways,been at the forefront of the globalization process andhas, as Anoop Singh (Director, IMF’s WesternHemisphere Department) explained, seen progresson numerous fronts. Technological advances intransportation have allowed tourism to flourish andenabled countries to diversify their economiesbeyond dependence on single commodities. Inrecent years, Caribbean countries with relativelycheap labor costs have also been able to benefit fromoutsourcing.

Increased regional cooperation was widely per-ceived as having great potential benefits. Given thesmall size of many of the region’s island economies,freeing up the movement of labor would allow forbetter use of skills and provide greater scope toexploit economies of scale. Nevertheless, the move-ment toward establishing the Caribbean SingleMarket Economy initiative has been slow. In theabsence of a powerful supranational authority andan intraregional transfer mechanism, such as in theEuropean Union, it has been difficult to implementthe necessary steps, even though the long-term bene-fits are universally recognized.

Why has growth lagged?According to Keith Nurse (Senior Lecturer,University of the West Indies), one of the mainimpediments to growth has been the region’s slowresponse to changes in the competitive environment.Kato concurred, underscoring the need for increasedflexibility given the changes associated with the glob-alization process and the region’s susceptibility toshocks. In the view of many participants, removinglabor market rigidities held the key to reducing highunemployment rates, enabling workers to movefrom declining to emerging sectors, and facilitatingadjustment to shocks—something that is particularlyimportant for the countries (like most of those in theregion) that have fixed exchange rate regimes. It willalso be critical, as local academics stressed, that theeducational system become more responsive to thechanging needs of the workplace and the increasingrole of knowledge in jobs.

Greater entrepreneurship and a more risk-takingbusiness environment can play an important stimu-lative role, as Sanjay Kathuria (Lead Economist,World Bank) emphasized. But this will requiregreater competitive pressure and a more supportiveinvestment climate. Also crucial, he added, is theeffective delivery of public services, which will, inturn, require more efficiency in collecting andspending tax revenue, and a larger role for the

private sector in the delivery of services.Kathuria cited India as a telling example ofhow these forces had combined to transforma number of sleepy old firms selling out-dated products into highly competitive,world-class companies.

Macroeconomic environmentThe single most important factor underlyingthe sharp accumulation of debt has been arapid increase in government expendi-tures—current and capital—rather than a stagnationof revenues. Over the past five years, as Ratna Sahay(Assistant Director, IMF’s Western HemisphereDepartment) explained, the fiscal positions havedeteriorated in each of the 15 countries in theregion. While negative external shocksplayed a part, policy slippages also occurred.The positive association between increasedpublic investment and economic growthobserved in many countries in the past hasalso broken down in recent years. Faced withhigh public debt, low growth, and reducedavailability of external grants, the room topursue countercyclical policies is increasinglylimited.

Several commentators underscored theurgency of addressing the region’s macro-economic imbalances. Nouriel Roubini(Professor, New York University) discussed thecausality between a buildup of debt and a decelera-tion of growth, noting that very high debt levels insome countries in the regionwere likely crowding out pri-vate investment and depress-ing growth. In his view, a rapidimprovement in fiscal balanceswas essential.

Sir Dwight Venner(Governor, Eastern CaribbeanCurrency Board) agreed thatthe focus needed to be on fis-cal adjustment. But he alsocautioned that developmentneeds should not be forgottenand pointed out that further development of thenascent government securities market would imposemarket discipline by rewarding responsible govern-ments and penalizing the laggards.

Many saw scope to tighten tax loopholes and redi-rect spending. In his remarks to the gathering, Singhnoted that “While the region’s tax effort is generallyrelatively high in proportion to GDP, there is stillmuch room to reduce tax concessions and exemp-

Williams:Globalization hasexpanded growthopportunities, but ithas also createdchallenges.

Sir Dwight Venner(left), Governor of theEastern CaribbeanCurrency Board),confers with IMFExecutive Director Ian Bennett.

Sahay: Fiscalpositions havedeteriorated in each of the region's15 countries.

tions, and reorient spendingaway from subsidies and wagesand toward greater infrastructuresupport.” Singh also cited wide-spread support for strengtheningfinancial supervision. “We havelearned from other countrieshow financial sector weaknessesand public debt vulnerabilitiescan interact to the detriment ofmacroeconomic stability andgrowth,” he said. Encouraging theregional policymakers, he notedthat “fiscal adjustment and struc-tural reform can initiate a virtu-ous circle toward debt sustain-ability and growth.”

Choosing betweencontinuity and change“Our economic aspirations are not so differentfrom our political and social objectives,” saidPatrick Manning (Prime Minister, Trinidad andTobago), arguing that sustained economic growthwould reduce poverty and bring benefits in manyother areas. While not as prevalent as in many otherparts of the world, poverty is a major concern inthe Caribbean. Many participants argued forimproving safety nets and opportunities for train-ing, especially in the context of enhancing flexibilityand the need to provide opportunities for displacedworkers.

“The challenge is how best to choose betweencontinuity and change,” Manning said. The consen-sus of the participants was that there had been toomuch continuity and too little change. But while

there was agreement on objectives, participantsstopped short of converging on the process forward.

A final panel discussion focused on the role ofinternational financial institutions in the Caribbean.José Fajgenbaum (Deputy Director, IMF’s WesternHemisphere Department) stated that the IMFintends to remain actively engaged in the region byproviding quality policy advice, supporting institu-tion building through the Caribbean RegionalTechnical Assistance Center (CARTAC), and extend-ing financial assistance in countries with IMF-supported programs. He also underscored thatCaribbean countries would need to take more pro-active control of their own policy agendas.

Tobias RasmussenIMF Western Hemisphere Department

Laura WallaceEditor-in-Chief

Sheila MeehanManaging Editor

Christine Ebrahim-zadehProduction Manager

Camilla AndersenElisa Diehl

Jacqueline IrvingAssistant Editors

Niccole Braynen-KimaniMaureen BurkeEditorial Assistants

Julio PregoGraphic Artist

_______

Graham HaccheSenior Advisor

Prakash LounganiAssociate Editor

The IMF Survey (ISSN 0047-083X) is published in English,French, and Spanish by the IMF22 times a year, plus an annualSupplement on the IMF and anannual index. Opinions andmaterials in the IMF Survey donot necessarily reflect officialviews of the IMF. Any mapsused are for the convenience ofreaders, based on NationalGeographic’s Atlas of the World,Sixth Edition; the denomina-tions used and the boundariesshown do not imply any judg-ment by the IMF on the legalstatus of any territory or anyendorsement or acceptance of such boundaries. Text fromthe IMF Survey may bereprinted, with due credit given,but photographs and illustra-tions cannot be reproduced inany form. Address editorialcorrespondence to CurrentPublications Division, RoomIS7-1100, IMF, Washington, DC20431 U.S.A. Tel.: (202) 623-8585; or e-mail any commentsto imfsurvey@imf.org. The IMFSurvey is mailed first class inCanada, Mexico, and the UnitedStates, and by airspeed else-where. Private firms and indi-viduals are charged $79.00annually. Apply for subscrip-tions to Publication Services,Box X2004, IMF, Washington,DC 20431 U.S.A. Tel.: (202)623-7430; fax: (202) 623-7201;e-mail: publications@imf.org.

June 28, 2004

196

The seminar on the challenges facing the Caribbean drew participants fromgovernment, academia, international organizations, local businesses, tradeunions, and the press.

The Group of Eight (G8) leaders agreed at their economic

summit meeting held on Sea Island, Georgia, United

States, on June 10 to continue providing debt relief under

the Heavily Indebted Poor Countries (HIPC) Initiative.

The leaders also directed their finance ministers to work

with donors, the World Bank, the IMF, and other interna-

tional financial institutions to provide “topping up”

financing to the HIPC Initiative, where necessary.

The HIPC Initiative, established in 1996, included a

“sunset clause” to avoid the adverse incentives of a perma-

nent facility, minimize moral hazard, and encourage early

adoption of reform programs. The initiative is currently

set to expire on December 31, 2004. G8 leaders recog-

nized, however, that the year-end expiry of the sunset

clause—which has already been extended three times—

would leave several countries with debts in excess of the

thresholds set by the initiative.

The Executive Boards of the World Bank and the IMF

will meet in July to discuss alternative ways of extending

HIPC debt relief. These options are intended to give heav-

ily indebted poor countries more time to put in place the

reform programs needed to establish their eligibility for

HIPC debt relief. A decision will be made by the World

Bank and IMF Boards in September in the context of a

review of the most recent progress report on the HIPC

Initiative.

G8 agree to continue providing debt relief under HIPC Initiative